Retire smart | Mark Miller: Law offers relief on distribution totals

Recognizing the bear market's severe effect, lawmakers approved an economic-relief measure before they adjourned this month that can be a big deal for many older retirement investors.

Recognizing the bear market's severe effect, lawmakers approved an economic-relief measure before they adjourned this month that can be a big deal for many older retirement investors.

The legislation suspends for 2009 the rules that force older individual-retirement-account holders and their beneficiaries to take minimum annual withdrawals.

The Worker, Retiree, and Employer Recovery Act of 2008 applies to required minimum distributions for IRAs, 401(k)s, 403(b)s and similar plans.

Under the current rules, IRA owners must take a minimum amount from their accounts starting in the year when they reach age 70 . The minimum distribution for a year is calculated against the IRA end-of-year balance the previous year; this year, the withdrawal will be geared to the higher market valuations that prevailed at the end of 2007. The rules also affect anyone who has inherited an IRA from someone already past age 70 .

With today's ravaged portfolios, the required minimum distribution is particularly onerous -- about $20,000 for a portfolio worth $500,000.

If you fail to take the distribution, you'd pay a 50 percent penalty on the amount you should have withdrawn but didn't.

The tax relief helps people who can afford not to withdraw funds for living expenses or take less than the minimum.

If you do have other sources of money to pay bills, this legislation allows you to leave more money in your tax-deferred IRA, giving it time to rebuild as the market recovers.

"If you spend the IRA dollars first, that accelerates your tax payments," he said. "When you do that, you will always run out of money faster than the person who spends the after-tax money first because you've taken funds out of a tax-sheltered account and those funds are no longer there to keep growing."

The other downside of minimum distributions is the hit in income taxes.

"Say you want to spend $50,000," Lange said. "If you take it out of your IRA, that triggers a tax of about $13,000. After you pay the tax, you only have $37,000, and you have to go into other funds for the rest of what you need."

The minimum-distribution suspension could also save you money on your tax bill. Because you won't have that income reported on your tax return, you could drop into a lower tax bracket -- and be able to convert a traditional IRA into a Roth.

There's one important caveat to consider if you do a conversion of this type: the potential of higher taxes on your Social Security benefits. Any income that you realize in a Roth conversion would be used in that year to calculate the taxes you owe on Social Security, so be sure to run the numbers or consult your tax adviser before you commit to a conversion.